Westin Leavitt and Dr. Mark Hansen, Management Program
As America’s healthcare industry becomes increasingly regulated under the Affordable Care Act (ACA), the economic effects of regulation are still in question. One of the most puzzling questions is the price at which hospitals and clinics will charge for treatment. Because hospitals’ costs and prices are usually proprietary knowledge, we suspect that hospitals are participating in first-degree price discrimination* to maximize profits. In addition, we seek to explain how the ACA’s partial reimbursement rates cause greater financial stress on hospitals by forcing them to cost shift**.
Other industries have been in similar regulated markets. The US airline industry transitioned to deregulation in 1978, under President Carter’s administration. Since then, airline companies have begun to compete on price—introducing price discrimination techniques based on what the customer is willing to pay. This strategy, as well as cost-cutting plans, have saved the airline industry from financial distress. Our goal is to apply airline pricing techniques to the healthcare industry, thereby mitigating the financial pressure that federal regulation creates for hospitals.
Because healthcare is paid mainly by two parties, the government (31% of hospital revenues) and private insurance companies, effort was made to understand how each entities’ relationship with hospitals impacted treatment prices. To compare and contrast pricing policies in the healthcare and airline industries, we used to the following steps: 1. Identified future trends in healthcare pricing, 2. Explored what effects the ACA has on hospital pricing, 3. Interviewed a healthcare pricing expert to understanding current price strategies, 4. Researched whether price discrimination occurs and at what level(s) (patient demographic, insurance carrier, or government), 5. Collected any hospital price data that could indicate price discriminating companies, 6. Considered pricing strategies from airline applicable to healthcare providers.
Research indicates that generally, all hospitals practice first-degree price discrimination in the form of negotiation and cost shifting. In addition, we discovered that healthcare price discrimination happened at a high level by negotiating different prices with insurance providers, the government, and the uninsured rather than at the lower, individual patient level. Conversely, airline price discrimination is centered heavily on the consumer’s purchase behavior, not negotiations with large companies.
While hospitals are required by the US government to report prices of their most common procedures, the high prices listed rarely reflected the true price paid by insurance companies and/or government reimbursements. Experts show that on average, insurance companies only pay 39% of the original price listed for treatments. Insurance companies negotiate one-on-one with hospitals to set price points for services (figure 1). The US government does not negotiate, rather they reimburse according to a predetermined formula that includes labor, location, and added costs.
However, Medicare/Medicaid reimbursements have not grown with increasing hospital costs. In fact, plans to pay for the Affordable Care Act are in part financed by slowing Medicare payment updates1. As a result, hospitals are left with the financial strain of uncovered costs. Hospitals are then encouraged by the market to cost shift the remaining costs not covered by Medicare to private insurance companies—which in turn causes a majority of Americans to pay more for their insurance. Yet, the Medicare Payment Advisory Commission claims that reimbursement rate slowdown is an incentive for hospitals to cut costs, a claim we do not believe to be true. If hospitals can move costs to somewhere else, they will may not cut them.
Since airline deregulation in 1978, airlines have had to compete mainly on price. To maximize profits, they try to identify which customer would be willing to pay the most and when. Factors such as time of purchase, time of flight, destination, seat availability, refundability etc. influence airline prices (micro level). However, hospitals set prices at a higher level with government and insurance companies (macro level). Therefore, the individual patient’s demographics or time of treatment is left out of the hospital price equation. Because of this, the two industries may not be appropriate for comparison. This project could have been enhanced by choosing another industry that discriminates on the same level as healthcare providers.
Because the price insurance companies actually pay to hospitals is confidential, efforts to scale the degree at which certain hospitals are price discriminating were unrealistic. Pricing transparency issues will continue to be a stumbling block to reform as hospitals and insurance companies want to maintain a competitive advantage through secrecy.
Looking forward, the next step of this project would be to explore potential government reimbursement policies that would not encourage cost shifting to private payers. Encouraging the US Centers for Medicare and Medicaid Services to adjust reimbursement rates to adequately cover the cost of treatment would be an effective first step.
The Affordable Care Act puts considerable financial stress on hospitals by insufficiently reimbursing hospitals for Medicare and Medicaid patients (regulation). As a result, hospitals are covering remaining costs by charging private insurance carriers higher prices for the same treatments—a form of first-degree price discrimination. This ultimately requires the majority of Americans to pay more for their healthcare. While healthcare providers and the airline industry both price discriminate, their fixed costs, revenue model, and level of price discrimination depend on unique factors—negating the possibility of applying airline pricing strategies to the healthcare industry.
*charging different customers, different prices for the same care.
**taking the uncovered/extra costs of one’s bill and adding them to another’s.
1 Robinson, James. “Hospitals Respond to Medicare Payment Shortfalls by Shifting Costs…”. Health Affairs